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Is Exelixis Selling Itself Short?

It makes sense for the drugmaker to sell millions more shares right now.

Motley Fool Rule Breakers darling Exelixis (NASDAQ:EXEL) announced Monday that it was selling up to an additional 8.05 million shares in a dilutive financing.

Assuming these shares sell for around its current share price of just more than $10, this will bring in about $80 million to Exelixis' coffers after fees to the underwriter. The big question is: Was doing a financing now a sign of strength or weakness? Let's see what we can read into the deal.

Forecasting a fiasco in the future? Some astute investors posting on the Rule Breakers message boards smartly questioned why Exelixis, with $253 million in cash and investments as of the end of June, would bother selling shares. In fact, the drugmaker has been forecasting its cash and investments to be more than $200 million at the end of 2007, so it clearly has no immediate need for cash.

It was also pointed out that in just a few months GlaxoSmithKline (NYSE:GSK) will elect whether to pick up development of Exelixis' number two drug, XL880, and that a financing ahead of this event may signal that Exelixis is pessimistic about the odds of GSK grabbing XL880.

Both of these concerns are good points that any investor should be wondering about in regards to the financing. For several reasons, though, I don't think Exelixis investors need to be so worried about the drugmaker doing a deal now.

Au contraire. A sign of strengthWhile it's true that Exelixis' cash on hand is sufficient to fund its operations through at least the end of next year, the drugmaker will undoubtedly need more cash in the future, and it's always better from a negotiations standpoint to do a dilutive financing from a position of balance sheet strength than when funds get low.

While using the new funds for an outside product acquisition is near unfathomable -- as Exelixis' pipeline is overflowing with 14 compounds in development -- there is one acquisition for which Exelixis could use the money.

Exelixis could use the cash raised to buy back full rights to the three compounds -- XL784, XL647, and XL999 -- that it out-licensed the rights to in order to get funding from Symphony Evolution back in 2005 and 2006. Buying back the rights to these three drugs right now would cost Exelixis about $120 million.

An investor could make the argument that this financing is a bullish signal as Exelixis, per an agreement with Symphony, will need to buy back the rights to all three aforementioned compounds if GSK were to continue development of any of them.

XL647 has already been declined by GSK, but XL784 is the next drug up for GSK review. Furthermore, Exelixis just presented some really nice phase 2 data for XL647 and if it wanted to partner out the drug with someone besides GSK, it would likely have to buy back its rights from Symphony anyways. From any of these perspectives the financing looks like a very bullish signal from Exelixis rather than a sign of fear about XL880.

Avoiding a macro meltdown The drawback to doing the financing now rather than after GSK likely picks up XL880 is probably not too big either. There are plenty of macro events between now and December that could just as easily lower Exelixis' stock price as the GSK deal could raise it. National elections just around the corner and a new FDA mandate being debated in Congress, for instance, could change the whole pharma and biotech industries.

Since the start of August, the AMEX Biotechnology Index has been up more than 8%. But a biotech bear market could kneecap the shares of many undeserving drugmakers, even those with drug pipelines as promising as Exelixis'. Waiting to do a financing until after the GSK deal could mean raising cash in a biotech bear market on terms even more onerous to investors. As a general rule of thumb, development stage drugmakers should do financings whenever the capital markets will allow them -- like right now.

Final word on dilutive financings There are plenty of examples of drugmakers that waited too long to raise cash or could have done a share offering on better terms, such as Encysive Pharmaceuticals (NASDAQ:ENCY) or Dendreon (NASDAQ:DNDN).

The bottom line to me is that as long as the financing isn't at too much of a discount to Exelixis' share price, it makes sense for it to grab the cash now. Investors shouldn't try and read too much into the Exelixis share offering as the positive signals of doing the deal now are at least as great as the negatives.

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